¡Viva La Reforma!

Nick Niziolek

December 17, 2013

2013 may go down as a monumental year in Mexico's history. Soon after taking office,
President Enrique Peña Nieto announced the "Pact for Mexico," bringing opposition parties together with his
Institutional Revolutionary Party (PRI) to move forward with far-reaching structural reforms. This was a significant
positive development for a country whose political system had been deadlocked for more than a decade.
More importantly, President Nieto focused on reforms in education, labor, the financial system and the
energy sector—all critical areas for businesses deciding where to allocate capital. The pact's broad
scope includes privatization of the energy sector and improvements to lending rights and labor relations.

Also, President Nieto has taken a different approach to domestic security issues, with local headlines
increasingly dominated by economic optimism, as opposed to ongoing updates on the drug war. While more
progress needs to be made on security issues, an improving economy could ultimately provide a headwind
to organized crime in the region.

Given our positive view on Mexico and the impact reforms will likely have on multiple industries within
its economy, one might infer a case for broad-based exposure to the Mexican equity market via a passive
strategy or ETF. However, we believe that active management remains crucial for capitalizing on Mexico's
investment opportunities; bottom-up selection provides us with an important advantage in adding value.

Often, the emerging market investment story focuses on the consumer, but many of the larger consumer
companies in the Bolsa (the Mexican Stock Exchange) trade at rich valuations. So, although our bottom-up
research has uncovered opportunities tied to the consumer, it's not our greatest area of emphasis in Mexico.
Instead, our bottom-up work in Mexico is focused primarily on industries and companies we believe are most
likely to benefit from pending reforms and the re-acceleration of the Mexican economy. We've found opportunities within the Mexican banking sector, where companies are positioned to benefit from strong loan demand and improving credit and asset quality. Through select materials positions, we've sought to benefit from increased demand from the energy sector for a range of infrastructure needs, such as new plants.

Mexico's reforms and economic progress provide opportunities for companies outside of Mexico as well. Our team's bottom-up process focuses on where a company's assets are domiciled and where its revenues are generated. These are important drivers in understanding a company's growth potential and broadens our ability to access the growth story we see unfolding in Mexico.

For example, we believe the railroad industry will be critical to Mexico over the medium-term, with energy reforms and a North American manufacturing resurgence supporting significant growth potential. Yet there are limited Mexico-domiciled companies from which to choose, leading us to also seek out developed market opportunities with significant links—such as revenues and assets—to the Mexican rail industry.

We believe our revenue-based approach also has been advantageous in the energy equipment and services industry. We expect significant growth within the Mexican oil industry on the back of reforms, but there are limited choices for investing in local companies positioned to benefit from these improvements. To address this, we have also identified several global energy and equipment companies that we believe can capitalize on the increased demand we expect over the next few years.

Moreover, while the tapering of quantitative easing in the U.S. and a stronger dollar may create headwinds for many emerging markets and emerging market currencies, we believe Mexico is not as vulnerable as countries struggling with weakening currencies and current account deficits, such as India and Brazil. Given its close ties to the U.S., the Mexican economy could benefit notably from U.S. economic recovery. Reflecting this view, as U.S. taper talk unsettled the global market in May and June, we used the sell-off to opportunistically buy Mexican equities.

We believe the growth story in Mexico underscores the benefits of an investment process that is both top-down and bottom-up. One might argue that a top-down view is the most critical element in emerging market investing; incremental improvements in economic freedoms may have significant long-term impacts on capital flows into these countries and the growth potential of the companies competing in these markets. Yet, in our opinion, a correct top-down view is only half of the solution. Strong fundamental research remains essential, as not all companies will benefit in equal measure from our top-down outlook. Moreover, many beneficiaries may be located outside of a particular emerging market.

Heading into 2014, we remain optimistic about the Mexican economy and believe we have identified a number of strong bottom-up opportunities that will continue to benefit from these positive developments. ¡Viva La Reforma!

The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Information contained herein is for informational purposes only and should not be considered investment advice.

The information in this report should not be considered a recommendation to purchase or sell any particular security.

As a result of political or economic instability in foreign countries, there can be special risks associated with investing in foreign securities, including fluctuations in currency exchange rates, increased price volatility and difficulty obtaining information. In addition, emerging markets may present additional risk due to potential for greater economic and political instability in less developed countries.

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